Morning Markets Brief 11-3-2021

Summary and Price Action Rundown

Global risk assets are steady as investors await today’s pivotal Federal Reserve decision and look ahead to key US labor market data. S&P 500 futures indicate a slightly lower open after the index added 0.4% yesterday, registering another all-time high and upping year-to-date returns to 23.3%, while the Nasdaq kept pace. EU equities are slightly higher, while Asian stocks were mixed overnight. Longer-dated Treasury yields are holding steady ahead of the Fed, with the 10-year hovering at 1.53%, which is still in the upper half of its 2021 trading range. Meanwhile, the ongoing rebound in the broad dollar index is stalling below its recent year-to-date highs. Crude prices are reversing lower ahead of this week’s OPEC+ output decision, with Brent crude sinking back toward $83 per barrel. President Biden has continued to call on the cartel to up supply in order to restrain crude prices, which are at multi-year highs.

Pivotal Fed Decision Awaited

Treasury markets have steadied in recent days ahead of what market participants expect will be an announcement of the details of the Fed’s plan to reduce its asset purchases (aka quantitative easing or QE) over the coming months. Fed Chair Powell is expected to reveal the timeline and trajectory for the tapering of QE, with the markets pricing in an immediate start to the process at a pace of roughly $15 billion per month. Importantly, communications by Fed Chair Powell and other FOMC members have emphasized that the tapering process is independent of the decision to hike interest rates, given the different preconditions set forth for these policy moves, with the bar being considerably higher for the latter than the former. However, financial markets appear unwilling to accept the Fed’s attempted de-linkage of the two, pricing in rate hikes starting as early as June or July next year, almost immediately upon the anticipated conclusion of the tapering process, with another full rate hike priced in before year-end. This is more aggressive than the median FOMC interest rate projections (aka the “dot plot”) and aligns with the three most hawkish Committee member dots for next year, and the market-implied projection remains on the hawkish side of the median for 2023, before leveling off in 2024. Analysts are pondering whether Fed Chair Powell will attempt to reassert the median dot plot trajectory, similar to the dovish rhetoric on interest rates from European Central Bank President Lagarde this morning (more below) and Reserve Bank of Australia Governor Lowe the prior day. – MPP view: If the Fed wants to push back rate hike expectations and steepen the yield curve, similar to what ECB President Lagarde is doing, they can accomplish this by putting the start date of the taper in December – this would be a signal to the markets that the current dot plot is still operative, and we think this is an attractive and likely policy option. This approach would also help put a floor under the yield curve and show that the Fed hasn’t completely thrown in the towel on its “transitory” thesis, which we think is still a very credible narrative for most of the ongoing price pressures.

We are skeptical that rate hikes will swiftly on the heels of the conclusion of tapering, particularly since we retain the out of consensus view that the Fed Chair position will go to Governor Brainard but also due to our expectation of easing inflation rates over the coming quarters, as public health improvements feed through to improving economic activity.   

First in a Trio of Key US Labor Market Readings Due Today

After two successive months of disappointing nonfarm payroll tallies, this weeks’ string of jobs data for October are expected to yield relatively more encouraging figures. However, today’s estimate of new private sector jobs in October, complied by employment services giant ADP, is seen easing modestly from 568k in September to 400k last month. For context, the ADP jobs reading for September was considerably more upbeat than the nonfarm payroll headline number, which dramatically undershot expectations of 500k with a tepid print of 194k, although the unemployment rate continued to fall faster than anticipated, declining to 4.8%. Friday’s October nonfarm payroll reading is expected to improve to 450k and the unemployment rate is projected to dip to 4.7%. Lastly, tomorrow’s jobless claims total for last week is expected to mark another new low for the pandemic at 275k from the prior week’s 281k.

Meanwhile, overseas, the EU-wide unemployment rate dipped to 7.4% in September, in line with estimates, from 7.5% in August. This is the lowest jobless rate in the bloc since April 2020, though data shows there are still 600K fewer people employed than before the onset of the pandemic. European Central Bank President Lagarde reiterated this morning that the conditions for beginning to hike interest rates are unlikely to be satisfied next year, pushing back on financial market pricing of liftoff by October 2022.

Additional Themes

China’s Service Sector Holds Up – After yesterday’s release of China’s October manufacturing Purchasing Managers’ Index (PMI) reading showed the continued impact of power shortages and other headwinds, remaining in contractionary territory, the non-manufacturing PMI figures overnight reflected ongoing strength. Specifically, China’s official service sector PMI for October beat estimates, registering a solid 53.8 versus expectations of 53.1 and the prior month’s 53.4. For context, PMI readings below 50 denote contraction in the sector’s activity. Later today, US service sector ISM PMIs are expected to show continued strength with a consensus forecast of 62.0 following 61.9 in September. – MPP view: Our expectation is for downbeat manufacturing and property investment growth in China over the next few quarters before the government begins to get more serious about stimulus in the leadup to the National Party Congress next October, where President Xi and the powers that be will want positive atmospherics around his ascent to a historical third term.

Earnings Season Remains Supportive of Stocks – The generally upbeat tone of earnings reporting for the third quarter (Q3) has continued to provide a tailwind to US equities despite US fiscal and monetary uncertainty, as concerns that supply bottlenecks, high input prices, and labor shortages would sap corporate profitability have been generally allayed. Today, CVS, Marriot, and Norwegian Cruise Lines report before the opening bell, while figures from Qualcomm, EA, and Allstate are due after the close. With 363 of the S&P 500 companies having issued Q3 results, the figures have been impressive, with reporting companies beating sales and earnings estimates at rates of 66.9% and 82.1%, respectively. – MPP view: With Q3 earnings season pretty much in the books, the margin squeeze/bottleneck/input costs/labor shortage dogs didn’t do as much barking as feared and we expect increasing signs of easing some of the snags and shortages over the coming months.

Democrats Grope for Consensus as Political Heat Rises – Reports this morning indicate that Congressional Democrats are continuing to bargain over the terms of the reconciliation bill, which needs to pass with an elusive level of nearly unanimous support across the caucus given the lack of GOP support. Specifically, Democrats are said to be considering an expansion of the minimum tax concept from corporations to the wealthy, which would be balanced against the lifting of the state and local tax (SALT) deduction cap imposed by the Trump administration. This comes after news last night that an intraparty compromise had been reached on lowering prescription drug prices. As the votes on both bills in the House, which Democratic leaders had hoped could be held as early as last night, slip further into the future, political developments are raising the temperature on the party. The Trump-linked Republican candidate Glenn Youngkin beat party mainstay Terry McAuliffe in the Virginia governor’s race, while the New Jersey’s gubernatorial election remains too close to call this morning. Democratic candidates had been favored in both races for much of the campaign. – MPP view: On balance, we expect that the disheartening results for Democrats in these gubernatorial races will help focus minds in the caucus on getting these bills over the line, but there is still no clarity on the timing of the House vote. While there remains a sense of momentum and we think the odds of near-term passage remain relatively high, if timeline for a vote slips into mid-November or later, the odds worsen markedly.